investment viewpoints
How the Russia-Ukraine war could impact equities
War in Ukraine is tragic and achieving peace is the undisputed priority. But as investors, our task is to seek the best way to manage the resulting market volatility. This led us to ask: what can past geopolitical shocks tell us about the potential impact on equities, and how could disruption to Russia’s oil and gas exports exacerbate inflationary pressures?
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Systemic or idiosyncratic risk event?
The extent to which equity markets are impacted by the Ukrainian crisis will depend on whether the situation remains an idiosyncratic risk event or evolves into a systemic one. We believe the uncertain environment requires vigilance from investors and a focus on quality companies capable of funding their own growth without relying on capital markets.
An LOIM analysis of past geopolitical events and the resulting effect on commodity-linked inflation may help shed light on the probable impact of the current conflict. Using the S&P 500 index as a reference point, we can see that equity markets have typically reverted to normal levels within two months of conflict. In some cases, they climbed higher three months after the events (see figures 1 and 2).
FIG. 1: key geopolitical events
| Key events | Reference dates |
| Korean War | 21 April 1950 |
| Tonkin Resolution - Vietnam War escalation | 27 May 1964 |
| Yom Kippur war and the oil embargo (the first oil shock) | 03 August 1973 |
| Iran-Iraq War and the second oil shock | 21 July 1980 |
| Invasion of Kuwait | 01 June 1990 |
| US-led coalition war vs Iraq post Kuwait Invasion | 16 November 1990 |
| Kosovo War | 26 December 1997 |
| US-led Iraq War | 17 January 2003 |
| Libyan revolution | 16 December 2010 |
| Annexation of Crimea | 26 December 2013 |
Source: LOIM as at February 2022.
FIG. 2: S&P 500 performance before and after key geopolitical events
Source: LOIM, Bloomberg as at February 2022. For illustrative purposes only.
The impacts of Russian disruption
The 1973 Yom Kippur Arab-Israeli war is of particular relevance to the current conflict. It was followed by an oil embargo from Arab nations as a retaliatory measure, which led to a quadrupling of the oil price to USD 12 bbl, driving massive cost-push inflationary pressures resulting in the first oil shock that led to a recession. Over the same period, the yield on US 10-year Treasury notes rose from 9% to 12%, spiking at 14% in late 1975. This produced a difficult environment for equities until early 1976, when the US 10-year yield retreated to 8%.
Russia does not control oil markets to the same extent Arab nations did in 1973, but it is a very influential country in the commodity space and, therefore, this influence extends to commodity-linked inflation. Russia exports about 7.5-8.5 mbbld of oil and about 240-260 bcm of gas annually. Russian oil exports currently represent 8% of global supply. Any disruption to Russian flows will have a global impact given the fungibility of the global oil market and the lack of spare production capacity on a global basis.
Any disruption to Russian gas exports would have a disproportionate impact on Europe, since it is the destination for about 70% of Russian gas exports and the continent has limited alternatives. The closer countries are to Russia’s borders – especially those not lined by mountains – the higher the reliance on Russian gas.
In addition, the war could likely to disrupt Russian exports of other commodities, from palladium to platinum, as the nation provides:
- 44% of palladium (mostly for the catalytic converters diesel vehicles, and electrolysers)
- 30% of rough diamonds
- 25% of nickel production (mostly for stainlesssteel production)
- 15% of platinum (mostly for the catalytic converters in diesel cars, and jewelry)
- 14% of cobalt
- 12% of rhodium
- 7% of alumina (for aluminum production)
Russia and Ukraine are also key producers of soft-commodities, such as wheat, corn and seed oils. They primarily export to Turkey, Egypt, India, China, Nigeria, Bangladesh and Yemen. Developed economies are less directly exposed but would still suffer some inflationary price impact if there were to be any physical disruption during the planting or harvest season.
Russian banks: from SWIFT to China’s CIPS?
A number of Russian banks have been blocked from the Society for Worldwide Interbank Financial Telecommunication (SWIFT) international payments system as part of Western sanctions in response to the invasion. It is not yet confirmed which Russian banks will be denied access to the messaging system, or those that will be allowed to continue to use it. It appears likely that those Russians banks the most active in commodities will be able to continue using this system under specific conditions.
However, over the last few years, Russia has been developing its own messaging system – the System for the Transfer of Financial Messages (SPFS) – and authorities have also aimed to connect with China’s counterpart, the Chinese International Payment System (CIPS), in order to operate independently from SWIFT. None of these system have the clout of SWIFT, however, it will be important to monitor whether China moves forward in connecting SPFS and CIPS under the current circumstances. It would imply also that some key commodities then stand to be traded in renminbi, potentially challenging the US dollar in the long run.
Focusing on high-quality companies
Past events would suggest that, unless there are contagion effects that heavily influences macroeconomic conditions – such as the combination of surging energy prices, inflation or interest rates – geopolitical events tend to be episodes of idiosyncratic risk.
The market implications of the war in Ukraine remains a fluid situation and we are watching it closely. The key question is whether inflationary pressures caused by commodity-export disruptions are reinforced to the extent they become long-lasting, and whether this leads to higher nominal and real interest rates. This is currently not our base case.
A long-term bear market is usually not triggered by geopolitical unrest. It is therefore likely, in our opinion, that this correction is temporary. Our strategies remain entirely focused on high-quality companies with strong financial characteristics that can finance their growth without depending on capital markets. We believe these ‘self-funding’ companies are better insulated from external shocks and capable of demonstrating resilience in periods of heightened volatility.
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